Chapter 4, Problem 7PA

a.

To determine

Prepare the adjusting entry as at December 31, Year 1.

Explanation of Solution

Adjusting entries: Adjusting entries are those entries which are recorded at the end of the year, to update the income statement accounts (revenue and expenses) and balance sheet accounts (assets, liabilities, and stockholders’ equity) to maintain the records according to accrual basis principle.

Prepare the adjusting entries:

Date	Account titles and Explanation	Debit ($)	Credit ($)
December 31	Accounts receivable	5,280
	Studio revenue earned		5,280
	(To record the accrued studio revenue earned)
December 31	Supplies expense (1)	840
	Studio supplies		840
	(To record  the supplies expense)
December 31	Insurance expense (2)	300
	Unexpired insurance		300
	(To record  the insurance expense)
December 31	Studio rent expense (3)	2,400
	Prepaid rent		2,400
	(To record the studio rent expense)
December 31	Depreciation expense: Recording Equipment (4)	1,800
	Accumulated depreciation: Recording Equipment		1,800
	(To record the depreciation expense)
December 31	Interest expense (5)	144
	Interest payable		144
	(To record the interest expense)
December 31	Unearned studio revenue	4,320
	Studio revenue earned		4,320
	(To record the advance collections earned)
December 31	Salaries expense	648
	Salaries payable		648
	(To record the salaries expense)
December 31	Income taxes expense $\left(\$23,520-\$21,480\right)$	2,040
	Income taxes payable		2,040
	(To record the income tax expense)

Table (1)

1. To record the accrued studio revenue earned:

• Accounts receivable is an asset account and it is increased. Therefore, debit accounts receivable with $5,280.
• Studio revenue earned is a revenue account and it increases the stockholders’ equity account. Therefore, credit studio revenue earned with $5,280.

2. To record the studio supplies expense:

• Studio supplies expense is an expense account and it decreases the stockholders’ equity account. Therefore, debit studio supplies expense with $840.
• Studio supplies are an asset account and it is decreased. Therefore, credit climbing supplies with $840.

Working note:

Calculate the climbing supplies expense:

$\begin{array}{c}\text{Studio supplies expenses}=\left(\begin{array}{l}\text{Studio supplies in unadjusted trial balance}-\\ \text{Studio supplies in hand}\end{array}\right)\\ =\$9,120-\$8,820\\ =\$840\end{array}$ (1)

3. To record the insurance expense:

• Insurance expense is an expense account and it decreases the stockholders’ equity account. Therefore, debit insurance expense with $300.
• Unexpired insurance is an asset account and it is decreased. Therefore, credit unexpired insurance with $300.

Working note:

Calculate the amount of insurance expense:

$\begin{array}{c}\text{Insurance expense}=\frac{\text{Policy amount}}{\text{Number of months }}\\ =\frac{\$1,800}{\text{6Months}}\\ =\$300\end{array}$ (2)

4. To record the studio rent expense:

• Studio rent expense is an expense account and it decreases the stockholders’ equity. Therefore, debit studio rent expense with $2,400.
• Prepaid studio rent is an asset account and it is decreased. Therefore, credit prepaid adverting with $2,400.

Working note:

Calculate the amount of studio rent expense:

$\begin{array}{c}\text{Studio rent expense}=\frac{\text{Prepaid rent}}{\text{Number of months }}\\ =\frac{\$7,200}{3\text{Months }\left(\text{November to January}\right)}\\ =\$2,400\end{array}$ (3)

5. To record the depreciation expense, Recording Equipment:

• Depreciation expense is an expense account and it decreases the stockholders’ equity account. Therefore, debit depreciation expense with $1,800.
• Accumulated depreciation is a contra-account and it decreases the value of asset. Therefore, credit accumulated depreciation with $1,800.

Working note:

Calculate the amount of depreciation expense:

$\begin{array}{c}\text{Depreciation expense}=\frac{\text{Cost of the recording equipment}}{\text{Number of months depreciated}}\\ =\frac{\$108,000}{\text{60Months}}\\ =\$1,800\end{array}$ (4)

6. To record the interest expense:

• Interest expense is an expense account and it decreases the stockholders’ equity. Therefore, debit interest expenses with $144.
• Interest payable is a liability account and it is increased. Therefore, credit interest payable with $144.

Working note:

Calculate the amount of interest expense:

$\begin{array}{c}\text{Interest expense}=\text{Note payable amount}\times \text{Interest rate}\times \frac{\text{Number of months}}{\text{Months in a year}}\\ =\$19,200\times 9\%\times \frac{1\left(\text{December}\right)}{12}\\ =\$144\end{array}$ (5)

7. To record the advance collections earned:

• Unearned revenue is a liability account and it is decreased. Therefore, debit unearned studio revenue with $4,320.
• Studio revenue earned is a revenue account and it increases the stockholders’ equity account. Therefore, credit studio revenue earned with $4,320.

8. To record the salaries expense:

• Salaries expense is an expense account and it decreases the stockholders’ equity. Therefore, debit salaries expenses with $3,100.
• Salaries payable is a liability account and it is increased. Therefore, credit salaries payable with $3,100.

9. To record the income tax expense:

• Income tax expense is an expense account and it decreases the stockholders’ equity. Therefore, debit income tax expenses with $648.
• Income tax payable is a liability account and it is increased. Therefore, credit salaries payable with $648.

b.

To determine

Compute the net income for the year ended December 31, Year 1.

Explanation of Solution

Net income: The bottom line of income statement which is the result of excess of earnings from operations (revenues) over the costs incurred for earning revenues (expenses) is referred to as net income.

Compute the net income for the year ended December 31, Year 1:

Incorporation KHE
Income Statement
For the Year Ended December 31, Year 1
Particulars	Amount ($)	Amount ($)
Revenue
Studio Revenue Earned	$138,000
Total Revenue		$138,000
Expenses:
Salaries Expense	$22,248
Supplies Expense	$2,280
Insurance Expense	$3,516
Depreciation Expense	$21,600
Studio Rent Expense	$27,600
Utilities Expense	$2,820
Interest Expense	$1,152
Income Tax Expense	$23,520
Total Expenses		$104,736
Net Income		$33,264

Table (2)

Thus, the net income for the year ended December 31, Year 1 is $33,264.

c.

To determine

Explain whether the studio’s monthly rent for the last 2 months of year 1 is more or less than during the first 10 months of the year.

Explanation of Solution

Rent expenses as per the unadjusted trial balance is $25,200 which includes the rent expense for November. But, On November 1, it has paid $7,200 in advance for next 3 months and it was debited to prepaid studio rent account. Thus, the monthly rent expense paid for last two months of Year 1 would be $2,400$\left(\frac{\$7,200}{3\text{ months}}\right)$. The total rent expense for January to October would be $22,800$\left(\$25,200-\$2,400\right)$. Hence, the rent expense for the last 10 months would be $2,280$\left(\frac{\$22,800}{10\text{Months}}\right)$. Therefore, it is identified that the rent expense has been increased by $120$\left(\$2,400-\$2,280\right)$ in November and December.

d.

To determine

Explain whether the monthly insurance expense for the last 5 months of year 1 is more or less than during the first 7 months of the year.

Explanation of Solution

Calculate the average monthly insurance expense for January to July:

Particulars	Amount ($)
Insurance expense for 12 months ended	$3,516
Less: Insurance expense for August through December $\left(\$300\times 5\text{Months}\right)$	$1,500
Insurance expense for January through July	$2,016
Average monthly insurance expense for January to July $\left(\frac{\$2,016}{7\text{Months}}\right)$	$288

Table (3)

Insurance expense per month for last 5 months is $300. But the average monthly insurance expense for the first seven months of the year is $288. Thus, there is a difference of $12$\left(\$300-\$288\right)$. Hence, the insurance expense incurred in the last 5 months is $12 per month more than the average monthly insurance expense incurred in the first 7 months of the year.

e.

To determine

Determine the life of the equipment from the beginning of studios’ operation.

Explanation of Solution

Determine the life of the equipment from the beginning of studios’ operation.

Particulars	Amount ($)
Accumulated depreciation per trial balance	$63,000
Add: December depreciation expense (adjusting entry 5)	$1,800
Accumulated depreciation at December 31, Year 1	$64,800
Age of equipment at December 31, Year 1$\left(\frac{\$64,800}{\$1,800\text{Per month}}\right)$	36 months

Table (4)

Thus, the age of the equipment is 36months or 3 years.

f.

To determine

Indicate the effect of the adjusting entry on the income statement and balance sheet.

Explanation of Solution

Indicate the effect of the adjusting entry on the income statement and balance sheet.

Table (5)

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

Note:

“I” represents Increase

“D” represents Decrease

“NE” represents No effect